Alternatives to High-Frequency Trading Software

What Is High-Frequency Trading (HFT)?

High-frequency trading (HFT) software uses complex algorithms to analyze markets and execute large volumes of trades in microseconds. It requires advanced trading infrastructure, such as powerful computers with high-end hardware and low-latency networks.

Key Takeaways

• High-frequency trading software (HFT) accounts for about half of the U.S. stock market trading volume.
• HFT has been accused of manipulating the market and creating an unfair trading environment.
• Regulators in some jurisdictions have stepped in with efforts to reduce the trading activity.
• There are a few alternatives to high-frequency trading being considered.

Why High-Frequency Trading Is an Issue

The world of HFT also includes ultra-high-frequency trading, with participants of both types paying for access to exchanges that show price quotes earlier than the rest of the market receives them. This extra time advantage is believed to force other market participants to operate at a disadvantage, leading to claims of unfair practices and growing opposition to HFT.

The HFT marketplace has also become very crowded. Individuals and professionals have pitted their best algorithms against each other. Participants even deploy HFT algorithms to detect and outbid other algorithms. The net result is high-speed programs fighting against each other, squeezing wafer-thin profits even more, creating a trading environment in which regular traders cannot compete.

Additionally, the Securities and Exchange Commission believes HFT is an issue. In February 2024, the commission adopted rules that required firms acting like dealers to register as dealers (if they handle assets valued at more than $50 million). HFT firms act as dealers because they take both sides of trades and trade at “…a high enough frequency to play a significant role in price discovery and provision of market liquidity…”

Due to the above-mentioned factors and increased regulations, high-frequency traders and firms may consider alternative trading strategies.

Alternatives to High-Frequency Trading

Some firms are moving toward operationally efficient, lower-cost trading strategies that do not trigger greater regulation. 

Momentum Trading

The age-old technical analysis indicator based on momentum identification is one of the popular alternatives to HFT. Momentum trading involves sensing the direction of price moves that are expected to continue for some time (anywhere from a few minutes to a few months).

Once the computer algorithm senses a direction, the traders place one or more staggered trades with large orders. Due to the large number of orders, even small differential price moves result in handsome profits over time. Since positions based on momentum trading need to be held for some time, rapid trading within milliseconds or microseconds is not necessary, which saves enormously on infrastructure costs.

Automated News-Based Trading

News drives the market. Exchanges, news agencies, and data vendors make a lot of money selling dedicated news feeds to traders. Automated trades based on automatic analysis of news items have been gaining momentum. Computer programs can now read news items and take instant trading actions in response.

This news-based strategy can work better than HFTs as those orders are to be sent in a split second, mostly on open market price quotes, and may get executed at unfavorable prices. Beyond dividends, news-based automated trading is programmed for project bidding results, company quarterly results, and other corporate actions like stock splits and changes in forex rates for companies having high foreign exposure.

Social Media Feed-Based Trading

Scanning real-time social media feeds from known sources and trusted market participants is another emerging trend in automated trading. It involves predictive analysis of social media content to make trading decisions and place trade orders. 

Combining social media feed analysis with other inputs like news analysis and quarterly results can lead to a complex but reliable way to sense the mood of the market on a particular stock’s movement. Such predictive analysis is very popular for short-term intraday trading.

Firmware Development Model

Speed is essential for success in high-frequency trading. Speed depends on the available network and computer configuration (hardware) and on the processing power of applications (software). One concept is to integrate the hardware and software to form firmware, which reduces the processing and decision-making speed of algorithms drastically.

Such customized firmware is integrated into the hardware and is programmed for rapid trading based on identified signals. This solves the problem of time delays and dependency when a computer system must run many different applications. Such slowdowns have become a bottleneck in traditional high-frequency trading.

Is High -Frequency Trading Still Possible?

Yes, there are still trading firms trading at high frequencies using software.

Why Is High-Frequency Trading Illegal?

High-frequency trading is not necessarily illegal in many jurisdictions but is becoming more regulated. Some practices used by traders are illegal, such as spoofing, layering, and front-running, but these are not limited only to HFTs.

Do Brokers Allow HFT?

It depends on the broker—some allow it, and some don’t. If you’re interested in HFT, check with your broker to learn if it allows it.

The Bottom Line

Too many developments by many participants lead to an overcrowded marketplace and regulatory scrutiny. Traders are looking for alternatives to HFT by reverting to traditional trading concepts and low-frequency trading applications, and others are searching for new financial analysis tools and technology.